Mortgage Risk: Implementing Useful Strategies
Mortgage lending is all about risk assessment. What is a homebuyer’s willingness or ability to assume the risk associated with borrowing a large sum of money to purchase a home? What is a lending institution willing to risk in exchange for extending a mortgage? Assessment tools, such as a risk profile, can help identify what those levels of risk should be.
Mortgage Risk Profile
A risk profile is an evaluation of an individual’s or organization’s willingness and ability to assume risks. This is usually done in a tangible way, such as with a questionnaire. This can be used to objectively quantify risk assessment when considering various mortgage factors – time, rates, taxes, and future potential market fluctuations.
Assets and Liabilities
For an individual homebuyer, the ability to assume risk is directly tied to their assets and liabilities. An individual with higher assets than liabilities can afford to be riskier. Conversely, those with lower assets than liabilities will not only take less risks, but lending institutions will risk less on them as well. Lending institutions will certainly do their homework as to which category any buyer belongs.
Willingness and Ability
Ability does not always match willingness. For instance, some homebuyers can assume a larger risk than others but aren’t willing to assume the higher risk of a larger mortgage. Willingness and ability must both make sense.
For those who are investing in real-estate, the risk-return tradeoff is a principal of rising returns associated with rising risk. The drawback is that this comes with a higher uncertainty in the potential returns, and the risk of higher losses also remains. The converse here is also true.
Appropriate consideration should be given to the ability and willingness in this scenario as well. Outside factors such as taxes, markets, rates, and time can also affect risks and returns for investors.
Considering Both Sides
Whether looking for a first home or the 100th, home purchases always come with associated risks. Before allocating the large sums of money for a mortgage, serious consideration should be given to the accompanying risks.